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Did J.C. Penney Let Down Investors by Saying This One Important Thing?

Updated from 4:54 p.m. Aug. 14, 2014 with more information and analysis following the company's conference call.

NEW YORK (TheStreet) -- J.C. Penney (JCP - Get Report) reported yet another net loss, but surprised investors in multiple areas such as demand for activewear and cosmetics at Sephora, as well as profit margins and cash flow guidance.

The shares were up as much as 10% in after-hours trading, but gave a good portion of those gains back as the earnings conference call went along.  What may have let investors down was gross profit margin guidance for the third-quarter and the commentary underlying its expectation.

J.C. Penney, which my firm Belus Capital Advisors rates a hold, reported second-quarter net sales of $2.8 billion compared to the $2.7 billion Wall Street consensus. Same-store sales increased 6%, generally in line with management's guidance calling for a "mid-single digit" percentage gain.  Macy's (M - Get Report) announced a 4% same-store sales increase. 

A standout department for J.C. Penney was athleticwear, which CFO Ed Record characterized on the earnings call as "blowing the doors off."  The comments echoed Macy's CFO Karen Hoguet remarking that athleticwear was on "fire" in the second-quarter, aided by the introduction of new Nike (NKE - Get Report) and Under Armour (UA - Get Report) shop in shops at remodeled locations and the consumer trend towards athleticwear being acceptable as a daily, versatile uniform. 

Another area of strength for J.C. Penney was its home department, a business that represented 11% of annual sales in 2013.  In an emailed statement, a J.C. Penney spokesman provided that "home was up 25% in the stores this quarter", driven by "furniture, bedding, luggage, and bath."  The sales result for the home department in the second-quarter builds on the success the company had earlier in the year -- according to Bloomberg data, home sales accounted for more than half of J.C. Penney's first-quarter same-store sales increase of 7.4%.

The loss per share tallied 56 cents, or 37 cents ahead of consensus forecasts, fueled by gross profit margin expansion and expense levels that were better than management guided the Street back in May.  J.C. Penney's gross profit margins expanded 640 basis points year over year primarily from improvements in merchandise margins, and were stronger than management's guidance for a "sequential improvement." 

But, investors seemed displeased with management's gross profit margin guidance for the third-quarter.

J.C. Penney guided to second-quarter gross profit margins of "in line" to that of the first-quarter's 36%, with Record citing the need to be "a little conservative on the guidance" due to the typical promotional activity in the industry during the all-important back-to-school selling season.  Given that J.C. Penney remains a highly leveraged retailer with a stock price that has soared 52% in the past six-months on hopes the company's turnaround continues virtually unabated, the commentary on moderating progress on profit margins was unwelcome news. 

Given that CEO Mike Ullman has been responsible for laying the foundation of J.C. Penney's recovery, the news that he has undergone a "surgical procedure" was also unsettling. In an SEC filing, J.C. Penney stated that Ullman had "undergone surgery related to a medical condition he has had for more than 20 years," and that "Mr. Ullman is recovering and he expects to return to work soon."  When asked via email as to who was running day-to-day operations, a J.C. Penney spokesperson did not immediately respond.

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Tempering the concern on third-quarter profit margins and Ullman's health was J.C. Penney forecasting "positive" free cash flow in 2014.  On the last earnings call, J.C. Penney outlined "breakeven" free cash flow.  Bolstering that favorably revised cash flow outlook was an encouraging start to the back-to school selling season. “We are very pleased with back to school," stated Record, who went onto point out that same-store sales rose by a double-digit percentage in the last week of the quarter.  

Record's comments were also consistent to those offered by mall-based competitor Macy's.  "The end of the second quarter back-to-school was extremely strong at the start," mentioned Macy's CFO Karen Hoguet on the company's second-quarter earnings call.

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At the time of publication, the author's firm rated J.C. Penney shares a hold.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

-- By Brian Sozzi CEO of Belus Capital Advisors, analyst to TheStreet. This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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